But I still firmly stand by the proper castigation I gave to Austrian business cycle theory.

That was when I knew no one actually gets it. The “equity crisis” made people feel poor? How many average Americans were making purchases with equity?

I don't pretend to be an economist, but I have a very good education and I'm a whiz at math. It doesn't take a genius to figure out that the “consumption crisis” was spurred by the rise in gas and food prices that began nearly a year ago. The average American saw the price of essentials–food and fuel–skyrocket. “Middle class” plummeted to “borderline poor” in the span of about four months (May – August 08). Further, as any middle class wage-earner can tell you, that was simply the capper on several years of raises not keeping pace with the real cost of living.

(That food prices are not included in the inflation rate, and then the inflation rate is used as some indicator of purchasing power, boggles my mind. It's like calculating a launch of the space shuttle without considering gravity. You want a “theory of the events that predict revisions in an individual’s estimates of her lifetime income”? Start with personal budgets. The amount left over after food, clothing, shelter, utilities, and fuel is paid is directly proportional to how confident people feel about their lifetime income.)

The economic collapse and rising unemployment at the end of the year was just the roofing on the bunker, eliminating any tendency to spend “future earnings” and increasing the urgency of paying off any current debt. Americans were already pulling back. Now we're hunkering down in hopes that we'll get out of this crisis with jobs that pay a living wage.

Economists need to come out of their ivory towers once in a while.

Friedman, as you may know, was considered the “father of monetarism”, leader of the so-called Chicago School and has always trumpeted the virtues of laissez-faire markets. Modigliani, was an old-school Keynesian at MIT, important figure in corporate finance and generally favored activist fiscal policy, at least when he wasn't showering Friedman with exclamations like when he said “now we're all monetarists”.

The PI-LCH describes the discounted value of both transitory and permanent income, and destabilizing shocks to these income streams. While it's an accurate approximation, consumption behavior has developed even further once one takes into account liquidity constraints, myopia, bequest effects, and other time inconsistent preferences with exponential discounting. Oh, and let us not forget Robert Hall's theory of the random walk of consumption.

One final note: I'm as free market libertarian as anyone around, but it really is time to denounce Austrian macro. Austrian micro has made a splendid name for itself with its early discovery of marginalism thereby providing a rebuttal to Marx's labor theory of value, which, by the way, Marx took from early classical economists like Adam Smith and David Ricardo.

But as I read some of these comments here, and elsewhere, by idiots like Ron Paul, I am struck by the absolute absurdity of Austrian business cycle theory masquerading as anything intelligent and rigorous, which is almost invariably accompanied by a fetish for some gold or other metallic standard.

Cheers.

—Former Cato intern

“My argument, then, is that the various crises in economics are manifestations of inconsistencies in the neoclassical research program. These inconsistencies are present because of the curious admixture of Ricardianism and neoclassicism present in the modern research program. The inconsistencies were never resolved, though their resolution was in sight in the thirties when it was aborted by the Keynesian revolution. The current situation is the result of forty years of repressed debate over the very fundamental questions that occupied economists in the earlier period. We are now condemned to relive the debates unless we succeed in using the earlier discussion as starting points.”

Ed Dodson here:
One economics professor I have come to admire, Mason Gaffney (University of California, Riverside) has written very critically on the history of “repressed debate” within the economics community. However, he traces this problem of intellectual subjectivity to the late 1800s and the displacement of the political economy of Adam Smith with neoclassical economic theory that removed nature (i.e., land) as a distinct factor of production with characteristics quite different from that of labor and capital goods.

Gaffney was early in his career greatly influenced by Harry Gunnison Brown and Henry George (who I would describe as the last of the great political economists). Gaffney's analysis of the business cycle builds on the work of George and Brown, and he has provided us with a remarkably clear explanation of the interplay of markets for land, land, capital goods and credit. Keynes, for reasons he never explained, merely asserted that concerns about land monopoly expressed by his predecessors and a few stalwart contemporaries (John R. Commons, for example, as well as Brown) were not long an problem.

What is clear for anyone who looks at the real estate markets during the current business cycle is that credit-fueled speculation in land and real estate is the major problem. Skyrocketing land costs eroded profit margins for businesses and turned the residential real estate market into a casino of property flipping, outright fraud, predatory lending, and the creation of supposedly high yielding financial instruments secured more and more by speculative land values than by actual property improvements. We ignore the dynamics of land markets — and the public policies that drive their dysfunctional operation — to our continued risk of repeated economic collapse.